Economists tip cut in interest rate

Reserve Bank Governor Dr Alan Bollard. Photo / Mark Mitchell

Economists expect Reserve Bank governor Alan Bollard to cut the official cash rate from 3 to 2.5 per cent on Thursday in response to the February 22 earthquake.

A Reuters poll of 19 forecasters on Friday found 13 expecting an OCR cut, nine of them picking 50 basis points.

Short-term wholesale interest rates have already fallen in anticipation of a cut and that has already flowed through to banks' retail rates, including mortgage rates.

"Of course for those lower market rates to be sustained, the Reserve Bank will have to deliver," said Westpac economist Michael Gordon.

Expectations of a cut have seen the kiwi fall over the past week, hitting a 19-year low against the Aussie dollar.

Since the last monetary policy statement three months ago there has been a turnaround in business borrowing - one of the signs of self-sustaining recovery the central bank had been looking for. Underpinning that trend in increased business borrowing is also part of the case for a cut.

ANZ chief economist Cameron Bagrie said the earthquake had struck just as the economy was taking a turn for the better. That turning point had now been pushed back by six months.

"A rebuild effort bigger than Ben- Hur will support growth from 2012. The broader impacts on the economy are more difficult to estimate, but they will be negative, substantial and long lasting," he said.

"Monetary policy plays second fiddle to fiscal policy in events like this, but should still do its part. We believe the Reserve Bank should cut rates by 50 basis points, with at least 25 coming at [Thursday's] March monetary policy statement."

A rate cut is not without cost or risk, however.

The Reserve Bank's over-riding mandate is to keep inflation in bounds. To the extent a lower OCR also lowers the exchange rate it will make the inflationary pressure from rising world oil and food prices worse.

And the huge rebuilding task in Christchurch and Lyttelton is expected to stretch capacity in the construction sector for years putting upward pressure on prices.

But it is too early for the Reserve Bank to get concerned about spillover inflation pressures stemming from future construction activity, ASB chief economist Nick Tuffley says. "The reconstruction process is unlikely to reach full gear until 2012, by which time the Reserve Bank could easily remove the additional stimulus if needed."

Bollard still has breathing space as inflation indicators showed pressures being contained for now, he said. "When economic activity proved surprisingly weak over 2010, so did underlying inflation pressures."

BNZ economist Craig Ebert expects Bollard will cut the OCR on Thursday but is not convinced he should.

The arguments are not all one-way, he says. An OCR cut now could retard the process of getting the economy back on an even keel after the debt-fuelled excesses of the past decade.

One risk Ebert cites is of a renewed burst of borrowing in a rural sector enjoying record commodity prices, based on what could be artificially low interest rates.

A similar risk exists in the mortgage belt. At the moment a high proportion of mortgage debt is on floating rates. "A rate cut could see a significant chunk of this debt getting fixed at opportunistically low rates," Ebert said. The problem with that from the Reserve Bank's point of view is that a year or two down the track when it needs to tighten it would have less traction and would have to push harder to have the desired effect.

Thursday will also see the release of the bank's quarterly economic forecasts. Assuming they reflect a first go at factoring in the impact of the latest quake, Westpac's economists expect them to show close to no growth in the first half of this year, picking up in the second half as reconstruction resumes and accelerating beyond the 3.8 per cent peak previously projected for the middle of next year.

They also expect the forecast for unemployment to be higher and business investment lower over the near term, and a lower interest rate track over the next two years.